Accounting Probes Take Toll on Shares of Local Game Makers

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Accounting Probes Take Toll on Shares of Local Game Makers

WALL STREET WEST

Like other local technology companies, Activision Inc. and THQ Inc. were enjoying a rebound in their respective stock prices in recent months as part of a broader stock market comeback.

But the good times came to a halt after trading closed on July 18, when both video game makers disclosed in 8-K reports that the Securities and Exchange Commission was investigating their accounting practices.

The documents were filed late on a Friday, after the markets had closed for the week. The following Monday, Calabasas Hills-based THQ’s shares fell $1, or 5.6 percent, to $16.70 on heavy volume. Activision, based in Santa Monica, fell 9.3 percent to $11.29. Glen Cove, N.Y.-based Acclaim Entertainment Inc. and Midway Games Inc. have also said they are part of the industry probe. As of the middle of last week, the largest video game maker, Electronic Arts Inc., had not indicated whether it, too, was contacted.

Analysts said they believe the inquiry centers on the game publishers’ recognition of revenue being sold through third-party distributors. Under generally accepted accounting practices, only sales made to a retail customer are valid.

“The SEC investigation might be looking into the use of distributors before the product reached the end market,” said Shawn Milne, an analyst at SoundView Technology Group, an equity research firm.

Another major video game publisher, New York-based Take-Two Interactive Software Inc., said last year that the SEC was investigating its accounting practices after restating seven quarters’ worth of results, due to returns of products on which revenue had already been recognized.

Last week, Activision reported net income of $4.2 million (4 cents per diluted share) for the fourth quarter ended June 30, down from $20.7 million (21 cents) in the like year-earlier period. The results exceeded analysts’ consensus projections but the company warned that it would post a loss in the current quarter due to the delayed release of a game.

THQ was scheduled to report its quarterly earnings on July 24, after the Business Journal’s deadline. As of the close on July 23, THQ shares had rebounded somewhat to $17.52 each, while Activision’s remained at $11.37.

Among the non-gaming local tech crowd, a number of companies have managed to hang on to their gains.

Through July 23, the Nasdaq composite was up nearly 30 percent for the year. Local tech sectors were up even further. Computers, electronics and peripherals were showing a 70 percent gain year to date, led by semiconductor manufacturers International Rectifier Corp., up 55.6 percent to $28.73, Diodes Inc., up 133.6 percent to $22.45 and interactive program guide publisher Gemstar-TV Guide International Inc., up 53.8 percent to $5.00.

In the Internet sector, several companies profited from stronger relationships with industry leaders.

Online real estate information provider Homestore Inc.’s stock hit a 52-week high of $3.60 on July 16, after it reached an agreement to provide real estate listings to Microsoft Corp.’s MSN online service.

Computer software distributor Merisel Inc. hit a one-year high of $5.50 on July 16 following an announcement of a new e-commerce service provided in conjunction with Santa Clara-based security software leader Network Associates Inc.

In perhaps the most prominent pairing, paid-listings provider Overture Services Inc. jumped 12 percent on July 14 following news that Yahoo Inc. would acquire the company for $1.6 billion. Pasadena-based Overture’s shares closed at $24.15 on July 23.

Michael Thuresson

Temporary Rebound?

Given signs that the economy may be improving, some analysts are showing interest in the stocks of temp agencies and headhunting firms.

Earlier this month, analysts at Wachovia Securities upgraded Los Angeles-based Korn/Ferry International from “market perform” to “outperform” based on the company’s cost-cutting and a belief the labor market could rebound by the second half of 2004.

“We believe KFY is one of the premier executive search firms in the world,” wrote Wachovia analyst Mark Marcon in the July 7 report. “Though the market for executive search services is severely depressed, we believe that improving economies of labor markets in the U.S. and abroad will fuel strong demand.”

Since the release of the report, Korn/Ferry’s stock has risen 16.3 percent to a close of $9.34 on July 23. Its 52-week high of $10 was set on Nov. 11 of last year.

Others are not as optimistic, noting that the executive recruitment industry is running at three-quarters capacity. Before companies hire full-time employees and executives, they typically use temp agencies to meet initial spurts in demand.

So far, employment hasn’t picked up. The June unemployment rate rose 0.2 points nationwide from May, to 6.4 percent.

But Marcon insists there is pent-up demand for executives, and once the labor market improves earnings per share should follow.

“If the economy is turning the corner, we should expect at least several strong years of expansion similar to what occurred in previous recoveries,” he wrote. “For staffing and recruiting companies, our research indicates that there is typically strong and steady increases in demand during economic expansions.”

Andy Fixmer

Blame Game

For the second time in two years, officials of Malibu-based toymaker Jakks Pacific Inc. found themselves fending off angry Wall Street analysts and for exactly the same reason: Just after raising money from the Street, Jakks disclosed that its business was sucking wind.

Analysts were upset that Jakks hadn’t let on about the problems sooner, and wondered aloud on a conference call whether Jakks executives delayed their disclosure until after the June completion of a $98 million convertible note offering.

On July 22, Jakks reported lower-than-expected earnings for the quarter ended June 30, and lowered its guidance for the rest of the year, blaming SARS in China, where most of its products are made, and bad weather, which cut into sales of water toys such as Funnoodles.

Jakks Chairman Jack Friedman found himself having to make statements like these on the post-earnings conference call: “We’re a very ethical company,” he said. “We wouldn’t bag shareholders, nor would we commit certainly anything fraudulent.”

Analysts, meanwhile, were asking Friedman why they should place any faith in the new earnings guidance, and warning that shareholder lawsuits could be filed.

One year ago, Jakks executives similarly upset Wall Street by lowering their revenue projections only two months after the company and selling insiders raised $60 million in a secondary stock offering.

The Business Journal recounted the company’s travails in a package of articles in August 2002. “I think many institutions might feel duped, given the timing,” Bob DeLean, a Morgan Keegan analyst, said at the time.

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